The Right (And Wrong) Way To Spend Money At Your Startup
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- When I see founders that are spending too much money, it's because they haven't yet had that moment, that light bulb moment with any customers, that this is a thing that people want. And so they're kind of chasing that, they're trying to force it, and they think that if they can, the trick is to push harder and not maybe do something different. - One of the fundamental misunderstandings that a lot of early stage founders have, when they look at companies that have product market fit, at that point, what you need is growth.

and money can help buy growth. When you're pre-product market fit, the only goal is to find product market fit and money can't help with that. The only thing money can buy you pre-product market fit is time.

Welcome to another episode of Office Hours. I'm Brad, and I'm here with Pete, Nikola, and Gustav. And we have sat across the table with thousands of founders over the years talking about all sorts of crazy topics. And today we're going to talk about money and how to think about money, how to think about spending money, when is a good time to spend money, when is a bad time to spend money, what are great things to spend money on, bad things to spend money on, money, money, money. So the startup's kind of relationship to money or...

Maybe the attitude around money changes depending on the stage that the company's at. And so companies, let's say, that are pre-seed, as one might like to say, where it's day zero, they're just getting started. Maybe they're thinking about applying to Y Combinator or they're just applied to Y Combinator or getting ready.

How should they be thinking about money? What's the overall money strategy for a company that early? I think that's pretty simple at that stage. Like don't spend any dollar. Like only the very much necessary stuff. Yes, you need the laptop. Yes, you need the place to live.

If you had to guess, just thinking on the spot here, of all the companies we funded, say, in recent years, how much money have they spent? What's typical? How much money have they actually spent before we funded them? If I think about it, the number is very small. It's very, very small. Right. It might be tempting to think, oh, there's YC Funds companies and they've done all this stuff.

but they really haven't. I mean, we found companies before they even start working on the idea. That's right. So at that point, it's zero. And some people have worked for a while, maybe 10K over six months. And the vast majority don't even have bank accounts yet or even exist as an entity yet.

yet. In the earliest stages, you spend no money. You probably don't have to spend much money on anything. Okay. But then let's say you get out of that and you raise a seed round anywhere from half a million to $2 million. What are the things that are important for people to be spending money on or that we typically see people spending money on that we think good things?

The most common case for software companies, you hire one or maybe two engineers. And that is over a span of 12 months. And you know both of them. Okay, let's try to convince the best people. And you already know that they're pretty good. Have you worked with them in the past? Is it even better? Or like you know them from work or some school projects. And then you just kind of get a convincing game. You're like convincing them to leave their really other good opportunity. Yes.

And if you hire those two people, that's mostly what it's all about. For other roles, it's generally like contractors in the early days. You don't really need full-time roles besides one or two more engineers. Founders should be doing sales. Don't have a hire for sales or marketing until product market fit.

Yeah, this is kind of one of the dangers of having the money is that the things that you don't like doing. You're like, great, I can hire someone for this. Well, if you don't like doing it, you're probably not very good at it, which means you hire someone who's also not very good at it. So you have to learn the things. And this is another extremely common office hour for us is a founder reaches out. There's this person. They're so good at selling. I think they would be better than me at selling my product that I'm the only one in the world that understands.

help me figure out how to hire them and make them better than I am at selling this. And, you know, it's oftentimes a very disappointing office hour for that founder. We have to say, I'm so sorry. No one is coming to save you. You are on your own.

You've got to figure this out. Maybe a sales coach sometimes, we've seen some examples of that, okay? But bringing on someone to sell the product as a seed stage application of money is not good. - No one can sell the product better than the founder. For marketing too, as you can start scaling,

Who knows your market? Who knows your customers? Your ideal customer profiles? Nobody else than you. It's not because you are going to hire any marketer to do that for you. It's not going to work either. So sales and marketing are the last jobs to hire for. And to build on that point you gave earlier, as you are

Let's say you raise $2 million and you don't have product market fit. You have nowhere near it. You maybe a 10K in revenue and you're trying to figure out if there's retention there. The money you have in the bank is the time that you have to hit product market fit.

The more people, the slower you get to product market fit. Exactly. Because you become slow, there's a lot of inertia that you have to fight against. If you have a big team, then comes the problem of, hey, and you want to pivot for whatever reason, then you have a whole team to pivot. Given the time that you have, first of all, you can try multiple pivots in this time. Yes. And once something is working, you also have multiple chance to fundraise. Normally, I say people don't wait. Wait until you have maybe 14 or 12 months left and do your first attempt at fundraising or test the waters maybe.

And if it doesn't go well, you have another two shots actually. And then you can change things and improve things in that time. So like the more runway is better. I think oftentimes when I see founders that are spending too much money, it's because they haven't yet had that moment, that light bulb moment with any customers that this is a thing that people want. And so they're kind of chasing that. They're trying to force it. They haven't even seen it. Maybe they're first-time founders, so they haven't seen it in a previous company either. And they think that if they can... The trick is to push harder.

and not maybe do something different or find out more from the customer and let the market kind of pull it out of you. Do you have any tactics on how to be really frugal and disciplined with the money in the bank? I have a few tactics. One of them is to send an investor updates every month.

because accountability really matters. Having someone else looking at this every month actually forces you to be more accountable. And the second thing is to have two bank accounts and you put half of the money in the other one, pretend like you don't have it. And then you look at your bank account and be like, "Oh, I actually only have half the money that I raised." Okay. Let's say you are so fortunate to raise a Series A and you found some measure of product market fit. You raise $8 million, $10 million. How are you thinking differently about money now?

If you have actual product market fit, actually maybe you should hire sales. I mean, that advice may depend on your situation, but let's say you get one year, you get clear demand from the market and you are still the only one to sell the product. Of course, you can create a sales team.

that's a good way to sell the money as long as you know that anyone you hire is going to be accretive so basically they're going to make the company more money than you are going to spend on them if however you have a whatever program even if you have series a like don't buy billboards or don't do some crazy stuff because hey you are a series a you are a serious company now no of course not it's a way to uh maybe

It's never going to be the right time to do that. Only spend on something you can actually measure the impact of. But hey, hiring some good salespeople, yes, that's a good way. Yeah, I think you have to have a framework of when is each individual person overwhelmed by the inbound they're experiencing from this thing. So it could be an engineer who can't keep the system up and running. It could be a salesperson who's like, "I can't handle all the inbound." It could be customer service. You have to check in and see when are they to the point of breaking, and then you're like,

we have to have more people, it might often be too late. So you kind of have to have some insight and be like, well, you can't hire someone right away to solve the problem. So you have to kind of like, when do I anticipate based on the directory that these functions in the company is going to be overwhelmed. And I think that's how I would make my hiring plan. One thing you could do at that stage is to monitor how much revenue you make per employee. And that number should go up in time.

So that's another risk. That's maybe another tactic here to be careful about money. You want to be efficient. And the bigger you are, you should get kind of benefit of scale. And so you want that number of revenue per employee to go up. And if you monitor that, that's another good way to avoid the fate of overhiring

and then the revenue doesn't catch up. Going back to my advice of sending investors up, I actually think it's more important to communicate transparently with all your stakeholders or all the people that can keep you accountable. Because now that you have all this money,

and things are going well, it's like much easier to spend on the wrong things and people actually start paying attention. I would be just a little bit careful. Not all investors are going to tell you the right thing. True, true. Some investors may push you to spend too much. The scenario that I can spend my way to winning is just not generally a thing. Yeah.

Well, and it gets at the differing incentives between investors and founders, which is the founder, you have this entity and your job is to make it work and find the best version of it that will work. Investors make a lot of different bets and build a portfolio of startups and they're looking for the one that's going to work. And so they just operate differently about that. I think one of the mistakes that founders can make in this phase when sales are really starting to work, revenue is growing, is that they don't pay enough attention to retention.

If you're growing very quickly and you have a lot of revenue coming in, it's easy to ignore your churn. And that's a problem that will catch up with you in a year or two. And at that point, you've spent a whole bunch of money on growth and marketing chasing after bad revenue that's going to disappear. How should founders, whether seed stage or A or whatever, think about spending money on customer support?

and customer service? Is that in the name of churn reduction? Is that customer experience? Should they not spend anything on there and just hire more programmers? Companies win early stage by being much better at customer support than big companies. So you have to be much better at customer support than big companies. They also serve a point

as a handoff from the founders of understanding what the actual pulse of the customer is. Like, what do they like? What feedback are they giving you? And founders play this role for the longest time. At some point, you just can't answer every email, but you should be in every email. You should have a way to peek into the five customer service agencies that you have and see what's coming in.

use LM tools to summarize all of the work and see what's coming in there. But they are harder to understand the customer success role, I think, for a founder because it's something you do naturally and it's hard for you to find what it is. And to get to your earlier point, I remember when I was running my company, Perfect Audience, there were times when I would...

A customer would have a problem and I would almost be afraid to fix it same day because they would realize how small we were. Right. Like I still had this mentality of like, I want to look like a big company. I want to seem big. I need to put it in the queue. Yeah. We'll put it in the queue. Like that's like a cooler answer.

And we would fix it same day and good things would happen because of that. But I would always feel this like weird emotion like, oh gosh, I just really outed myself as being a little too involved here. But I think that's where the advantage comes. That's like the only edge you have as a startup is speed and responsiveness and all that stuff.

Okay, so Series A, you might hire for sales, your customer support, you're kind of building the machine that builds the product and takes it to market. Series B, should you get that far, what is the role of money in a company, Series B and beyond? It's different. Once you hit Series B, the companies that don't make it are the ones that don't actually understand the quality of their revenue.

and the people that have high quality revenue, they'll make it and things will continue to be good as long as you continue to have good quality of the revenue. And then once the race is here is B, and maybe it was premature and they don't have enough data to actually look at net dollar retention revenue or retention and customer retention or whatever usage, they will absolutely have fooled themselves at this point and say, "Well, there's three different investors in three different rounds that all bet on us and think that this is working. So it must be working because they have analysts and they have all these people that analyze our data.

But the ones that I've seen who it doesn't work are the ones that don't actually understand their own retention on their own revenue retention. And then that can go south. And like maybe the investor didn't understand either actually. Once you hit Series B, if it's actually high quality, like you're probably going to do well. By then you should have a revenue engine that you understand and that's predictable.

And then the money becomes just fuel in the engine. These engines, I think, are built around an understanding of how a customer goes from being a prospect who's never heard of your product

to a customer who's just starting to expanding predictably over the years. The best SaaS businesses have astronomical net revenue retention because they have figured out how to turn small customers into really big customers. Yes, absolutely. When I think about early stage spending and my own history as a founder,

I had these two extremes. There was a lot of time when I was very frugal, you know, sleep on a box on the floor, spend money on nothing. And then I had this other time when I had a split with a co-founder and I was grief stricken by this and just started hiring contractors left and right to like work on the product and spent way too much money in grief.

And so you talked earlier about like fooling yourself and not being honest with yourself. And I was telling myself making a leap forward on the product is the best thing that we can do. But it was just all a lie. I just didn't know what to do. And I thought spending money would be like an easier thing to do than to like sit back and think about a really wise way to use my resources. Can you really be a...

too lean, spend not enough. At some point, I remember after raising money, so we had money in the bank, like seed stage, and because I was at the time living in Paris and I had to travel to SF very often, I would book the worst hotel in the Tenderloin. That was such a bad experience. I wouldn't sleep well. I was not as good in meetings after that.

I think that was a bad way to save money. I'll give one example of a mistake that I see founders making today where I think they're being penny wise and found foolish is moving their startup after YC to a city where it's much cheaper to live and much cheaper to hire. I was one of those companies at the time when revenue was not popular.

like growth and usage was proper. So we were building a mobile messaging app in 2007, 2008, and we were tracking monthly active users and the retention of them. We weren't tracking revenue. We weren't making some amount of small revenue, but the only way that we can compare ourselves to like, are we doing well is the usage and not the revenue.

So in hindsight, I don't think anyone has this problem today. This is not really a thing that you track usage, you normally track revenue. But in hindsight, we didn't really know what X number of monthly active users would transform into for more fundraising. The only way for us to raise more to kind of continue was to raise more money. And it was kind of unclear actually. It was not like we were talking to investors and be like, "How many millions of monthly active users do you need to get another round?"

So for us, it was very unclear, I think, on are we spending too much, too little. In hindsight, yep, we were spending too much, I think. But we didn't have any... People tend to forget how the 2000s compared to today is in terms of the amount of information that's out there of like, today we can ask that question in 20 minutes, you talk to a bunch of people. At the time, it was unclear. There's a lot of asymmetry between the rounds and investors and founders, and founders weren't that connected with each other.

we're in a much better place today to be able to answer the question. What is the

most craziest thing that you've ever seen that founders spend money on? I don't know if it's that crazy, but sometimes, actually happened a couple of times to me recently, founders waste their money and the first thing they are going to do is to hire a branding agency, like 50K or whatever crazy amount of money, just to rebrand their company. New website, new fancy stuff, just such a waste of money. And often just a B2B company,

that nobody's going to find on their website anyway. It's going to be outbound. I don't have an example, but I do have an experience that I've actually experienced multiple times at YC, which is the company is, I think they're doing pretty well.

and then I don't hear from them for a year. And not hearing from someone who's doing pretty well, it can be an okay sign, but sometimes it's a very bad sign. And then guess what month I hear from them again? One month before death. And you hear from them, you're like, well, it wasn't actually going well, and all these things happen, and can you help us? There's one month left. They made a bunch of mistakes in this one year.

All of them made a bunch of mistakes and we were not aware because we weren't talking to them or they were not updating us or they weren't updating any investors. And it is very sad because most deaths, there's a function of spending money are preventable. If you just catch it early enough, it's preventable. But in order to be preventable, you have to get the diagnosis out early. So you have to know how things are going and when you're spending the money. And sadly, people...

I'm probably not updating investors because there may be kind of no deep down that like things aren't going well. And if I don't tell them, things will be better somehow. But then we can't help. The main advice I would draw here is that you should be transparent with people on how you're spending money. And you should communicate all these things because

We've seen the pattern matching of things that work out and don't work out, but we can only pattern match if we actually have the data. Yeah, this is a very common one, and I've talked about it before, but seeing early stage startups spending money on ads. And there's maybe some clever ways to do it. It's all very specific on the startup and where they're at and what they're trying to accomplish. But it's just so tempting and it feels so good to buy some ads and know that you're out there. And maybe you get a customer, maybe you get a customer there, a lead, something like that.

But you're really outsourcing your understanding of what's going on and how to even talk to customers. And there's no ad that's going to make you smarter. You don't learn anything when you get a customer from an ad at an early stage. Actually, it's worse than that because it becomes addictive. You spend on ads and so you grow faster. And then you get that expectation of continuing to grow even if the fundamentals of the business don't work.

And so you end up spending like, hey, you raised two million and then you continue spending because why? Like, hey, I have to show growth to my investors. And like, you know, I don't speak about churn. I don't speak about the things that actually don't go well. And that at some point, it's so obvious that the trajectory is going to hit a wall.

And the only way to continue is to raise money. And at that point, nobody wants to invest. I have this weird theory that there's a perniciousness to advertising also in the way that all the digital products work where you set a budget. It's like you're putting a ceiling on what you think your startup can achieve implicitly just by even engaging in this.

versus having more of a spirit of like, well, anything could happen today. I'm going to go as hard as I can, whether it's outreach, whether it's shipping stuff, like inherently you're locking yourself in to some assumption of like, what's the total good that could come from my startup right now? Oh,

All ad spend is either one or two categories. It's either experimental and small, or it's ROI positive. And then it's a payback time in months, and you know exactly how many months you get the money back, and you know that every single month. Those are the only two categories of ad spends that should exist. Founders that spend a lot on ads early on, also there's this opportunity cost because they miss out on figuring out a capital efficient way of acquiring customers. And so that when that money spigot turns off,

suddenly they don't know how to do it anymore. I had a company last batch and I started working with them, was joined through, like, okay, how do you do this? How do you do that? Getting to know them. And the only way that they got customers was through AdWords. And they fought so hard when I pushed them on this and challenged them, like, hey, you're missing out on some stuff.

And I asked them to switch off the ads for two weeks and see if they could match the same numbers and through any means necessary. And they ended up finding some really clever ways to like scrape government documents and permits and reach out to these people. And now they actually owned some way of finding customers and prospecting that they just weren't even thinking about this because it was so easy to just spend a little bit of money on AdWords. I have this framework around startups versus big companies in that

Startups are not miniatures of big companies where every single function that exists in the big company exists also in the startup. In fact, most things that big companies have, there are no equivalent in a small startup. Startups only exist to reach product market fit. Until then, nothing else really matters. Which means most of the things you end up spending money on at a big company, there is not a mini spend on that in a small company. It just doesn't exist at all. When startups get funded, every single dollar and every single

energy effort to go towards trying to find a parking lot that fit. Which usually is the two founders or the three founders, their computers, their apartment, and maybe one more engineer who's also probably an engineer that you hire. That's basically it. There's really nothing else that goes into this. When I see people making mistakes, they're looking towards the bigger companies, the enterprises or whatever, and they're like, well, if I had this and this and this and this,

I am now feeling more validated that my company is more grown up because it feels like a bigger company and I have some of these functions that bigger companies have even though you don't really need it. Like an office or ads or like you have people in departments they don't need. It makes you feel better more than it actually makes any difference whatsoever. In fact, it makes things worse because you have to manage these people in roles that aren't really needed yet.

It creates a huge distraction and it actually makes you spend all your time on the things that you don't, you can't really have distractions if we're trying to get a product fit. Like you can't, you can't spend time doing one-on-ones with people that work on other stuff. Like everything needs to go into like trying to get to these things. People spend money when they have money. And typically after a seed round, a lot of companies have a lot more money than they've ever had. And it just feels natural that I should have an office manager or I should have,

a really nice big office or maybe two offices or maybe a chief of staff. And there's like all of the things that just like you can look at other companies as successful and you kind of attach yourself to the things that they have and be like, if I only had these four things, then probably I'm successful too, but none of it matters and actually makes things worse. And to make it very plain, I think all of us have had this experience where we fund companies and the first

maybe even before the start of the batch, the first couple of office hours we have with companies, we're picking up on maybe what aspect of big company life a founding team has latched onto and is like already like subliminally recreating in some way, some attachment that they have that they might even not be aware of.

And so there's almost like a pruning that has to happen. We have to help them like release some of these assumptions to really pare it back down to being that single-minded organism. - Why do you think that is? Why is it that people,

want to hire for these roles, even though they just don't have a program like Fit, they're pivoting and they still want to spend money on things. Why do you think that is? I think that's what's expected from them. They don't know better. That simple. They worked in a big company, that's all they've seen maybe. Maybe. Or maybe an investor tells them, "Now you need to go

hard and so they think they have to spend. I think there's also some like fake it till you make it type thinking where hey, oh those people I read about them raising a Series A in TechCrunch and let me go on LinkedIn. Oh, they have this is what their team looks like. The sooner my team looks like that, the sooner I will raise a Series A. Let's be clear. Let's speak about runway a second here. All of that, all of these activities is going to reduce runway. The only thing that matters is to find product market fit.

Like the longer the runway, the more shots you have at that. The more chances you have to find that product market fit before you run out of money. Totally. And I think that's one of the fundamental misunderstandings that a lot of early stage founders have. And they look at companies that have product market fit. At that point, what you need is growth and money can help buy growth, right? When you're pre-product market fit, to your point,

The only goal is to find product market fit and money can't help with that. The only thing money can buy you pre-product market fit is time to figure it out. Every time you increase your burn, you're decreasing the one thing you need at that stage. There's maybe a mistake that people may do often. They raise a seed round, they have a lot of money and they think, okay, I need to survive for like 24 months.

So they take that amount of money, they divide it by 24 months, and then they get a burn number. Oh, I can burn that much money. And then they find ways to spend that money. No, of course not. Of course, you don't have to do that. Keep it lean, the minimum spend you can do to make progress towards product market feed.

And only when you get these signals of product market fit do you spend more because then you'll know what to spend it on. And if you have remaining money from your seed, you can actually grow much faster towards your Series A. That's the right time to spend. I also think that the attributes that attach to looking like a bigger company is the thing you want to talk about. If you go to an event or a startup party or whatever, people are probably going to ask you about how many employees you have or

or like, who are your investors or something like that. They're not going to ask you, what is your retention rate or your net dollar retention rate? Which are actually the two numbers that you would want to talk about if you want to speak about having a pocket money fit. How many outbound emails are you sending on a daily basis? No one's going to ask that. They're not going to ask that. They're not going to ask the things that actually matter. They're going to ask you about things that make you appear bigger and more validated, but in reality don't matter. During the SERP era, summer 2020 to another two years past that,

I saw companies going from basically being validated by investors and they would raise a seed round from YC, maybe a couple of million dollars, and then very quickly they'd raise the CRSA. So maybe that was like 10 or $15 million. And then somewhere between those two, they forgot all the things that matters. And the burn would go from like two or 300 to in some cases, a million dollars a month. And they were still at a million ARR.

a million ARR and spending a million dollars a month. And there were CSA investors on their board that didn't... I actually don't know the details, but didn't seem to actually pull the brakes here until it was too late. What do you think was the psychology behind the founders doing that? What were they telling themselves on a daily basis? Well, I think fundamentally, and I'd love to talk about this, is that they weren't honest with themselves. They somehow

have the money and push the gas in all of the spend and just

thinking that the revenue will catch up, but it almost never does. You can't have like 10 or 12 X spend to revenue and assuming that it'll catch up. That doesn't really happen. I think that reasonable investors will be able to help you and say, stop, don't do this if you send them updates. If you keep in touch with the investors and if you tell them every month how things are going, and specifically the things that we look for first in our invested updates, like what's your runway, what's your burn, what's your revenue? Those are the core metrics before we dive into all the other stuff. Because

More often than you think, people get off track and they maybe had a very easy fundraise, the first few fundraisers, and then they just kind of becomes irrational assuming the next one will work. It's very clear that what happened in those two years after summer 2020 hurt companies

Like, it was much worse than just like more of the same. You heard companies that otherwise would have been successful because they would have had a level of discipline that was forced upon them, which they now didn't have to have. And now, I mean, at best case, the cap tables are messed up, but worst case, they're dead. I've seen a lot of founders make the mistake of putting together a financial model before they raise.

And the financial model has a bunch of assumptions about how many people they're going to hire. And it has a bunch of assumptions about how quickly they're going to ramp revenue. It's always linear. It's always linear. And it's very common to hit your hiring targets. And what's the quality of the people you're hiring if you hit your hiring targets as a startup? Basically, no one wants to work for your C startup. Yes.

There are big companies to work for that pay a ton of money. There's medium-sized companies who are like superstars. There's open AI. There's all these opportunities for people to work for. Why would I work for the seed funding company and be like the first employee? It's just not that attractive to the person who doesn't know about you. Maybe if I know you, I know you're a great founder, I would want to work for you. But for most people, this is not interesting to work for, which means the time it takes to hire will be very long. And if it goes really fast, you probably hire the wrong people.

Okay, so we've just talked about a bunch of things that you could spend money on that you might spend money on that you shouldn't spend money on. And we looked at how the startups relationship to money changes a bit as they grow and proceed through the different stages of startups. I hope as you're thinking about your own startup finances, whether you have $0 in the bank, $2 million in the bank, $10 million in the bank, I hope that you found some of this useful, and we'll be able to make better decisions about your startup finances because of it. Thanks for watching, and we'll see you on the next office hours.

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